1. Why a companys actions to increase its operating leverage results in increasing the companys equity Beta? Explain.

2. Company Ps capital structure contains 10% debt and 90% equity. Company Qs capital structure contains 50% debt and 50% equity. Both companies pay 8% annual interest on their debt. Shares of Company P has a Beta of 1.1 and the shares of Company Q have a Beta of 1.45. The risk-free rate of interest equals 5%, and the expected return on the market portfolio equals 12%.

Required: Refer to the information in (b) above and answer the following questions:

1. Calculate the Weighted Average Cost of Capital (WACC) for both companies assuming there is no taxes.

2. Recalculate the WACC for both companies assuming there is a tax rate of 30%

3. Which company is benefited more for the tax effect on its WACC? Why?